7 Ways to handle home renovation financing

With so many homeowners sitting on ultra-low interest rate mortgages, there’s a reluctance to move into a new home. Rather than moving, homeowners are adding rooms and upgrading their homes to meet their needs. Learn about the average cost of a home renovation, the most common projects, and how to finance your renovation.

How much is the average cost of a home renovation?

The average cost of a home renovation ranges from $19,481 to $88,369. However, your actual cost will vary based on where you live, the type and age of your home, and the project you want to complete. Here are the average costs of a few of the most common types of home renovations and how much you can expect the project to increase the value of your home:

When undertaking a home renovation, make sure you get permits so you don’t have problems when selling your home. Get quotes from multiple contractors and ensure they are licensed and insured before signing a contract.

Not only can renovation projects increase the value of your home, but the interest on home improvement projects may be tax-deductible. Consult with a tax advisor to determine whether your home renovation project qualifies for these valuable tax benefits.

How to finance a home renovation

With estimates in the tens of thousands of dollars, most homeowners need a property improvement loan to finance their renovation projects. This allows you to spread the cost over a number of years and keep the payments affordable. The most common loan options for home renovation financing are typically unsecured loans vs home equity financing:

Unsecured personal loan

A personal loan is a solid choice for smaller home renovation projects. These loans are unsecured, which means that you don't have to pledge any assets to back up the loan. Instead, the approval is based on your personal credit history and your ability to repay the loan. Unsecured personal loans tend to have higher interest rates than a mortgage or home equity financing, so you'll want a shorter loan term to keep your interest costs to a minimum.

Personal loans are available through traditional banks and credit unions, but you can also apply for them through online lenders. The maximum loan amount varies by lender, but you can generally borrow up to $50,000, depending on your credit qualifications. There are no restrictions on how you can use the money, but borrowers often use it for home renovation projects, debt consolidation, vacations, or starting a small business.

Home equity loan

A home equity loan provides a lump sum of cash to finance your home improvement project. These loans offer a fixed monthly payment with fixed interest rates that are locked for the duration of your loan. These loans sit secondary behind your primary mortgage, so you won’t lose your current interest rate. However, you’ll start paying interest on the entire loan amount immediately, even if you don’t need the money right away. And if you need more money to complete your project, you’ll need to apply for another loan or find another way to cover the costs.

Home equity loans typically range from 5 to 20 years, but lenders allow you to select the repayment timeframe that matches your budget. Shorter loan terms reduce your interest costs, but increase your monthly payment. Extending the loan term keeps payments more affordable, but you’ll pay much higher interest costs.

Home equity line of credit (HELOC)

HELOCs offer flexible financing with a variable interest rate and a maximum credit limit. Once it’s open, you can borrow from equity lines of credit whenever you need the money. This keeps your interest costs lower because you’re only paying interest on the money you’ve actually used during the draw period. Your minimum payment is interest-only, but you can pay extra to lower your balance and future interest costs.

However, interest rates on home equity lines are variable, so your payment can change from month to month, even if your balance stays the same. A valuable feature of a HELOC is that as you pay down your balance, you free up available credit that can be used in the future. This flexibility allows you to use these equity lines of credit for multiple purposes beyond your renovation project, such as buying a car, consolidating debt, or paying for college tuition.

One the draw period ends, the balance is converted into a principal-plus-interest loan. This free online tool can help you see what your HELOC payments may look like.

Home equity investment (HEI)

Home equity investments are an excellent way for homeowners to get home improvement loans without being saddled with another monthly payment. HEIs allow homeowners to access up to $600,000 from their home equity, yet they do not have monthly payments. Instead, you share in the appreciation of your home when the investment is settled. So both you and the lender benefit as your home appreciates in value.

If you're self-employed or your income fluctuates throughout the year, conventional financing can be a challenge. Getting an HEI is easier than a traditional home loan because there is no income verification and you can get approved with less-than-perfect credit.

Cash-out refinance

A cash out refinance replaces your current mortgage with a new home loan with a higher balance. Upon closing on your new mortgage, the lender will write you a check or deposit money into your bank account. Unless you opt for a shorter term, refinancing your mortgage also resets the payoff date of your mortgage. If you're 10 to 15 years into your current mortgage and choose to refinance, consider getting a 15 or 20-year mortgage instead of the traditional 30-year term. This will keep you on track to pay off your mortgage near the original payoff date.

Refinancing your mortgage takes the longest to complete of any way to finance home renovation projects on this list. More than 70% of homeowners have mortgages with interest rates below 5%, so replacing them with a mortgage at 6% or higher can dramatically increase their payments. Additionally, the closing costs for a new home loan can range from 2% to 5% of your loan amount. These property improvement loan costs include lender fees, points, appraisals, title, attorney or escrow fees, and other fees.

Credit cards

For smaller projects, homeowners often use their existing credit cards to pay for home improvements. Yet, credit cards typically are the worst type of financing for home improvement projects. The typical APR on a credit card is around 20% or higher, depending on the card and your credit score. Minimum payments on credit cards are generally 2% to 3% of your outstanding balance, but this barely moves the needle on your balance, so it can take a long time to pay off your purchases.

However, if you qualify for a 0% intro APR offer, a credit card can be a solid option to pay for your project that’s within your credit card’s available credit. The downside is that these promotional interest rates usually last for 24 months or less, depending on the card. So, you’ll need to pay off the project quickly to avoid paying sky-high interest rates or having to transfer the balance to another intro APR offer. This can lead to higher-than-expected payments that are beyond many homeowner budgets.

Community grants

Seniors and people living in low-income areas may be eligible for grants from community organizations that cover the cost of certain home renovation projects. These grants typically fund projects for weatherization, energy efficiency, and senior-care needs. Unlike the other ways to finance, many of these community grants don’t need to be paid back. Others are low interest loans that keep payments low for people living on a fixed income or near the poverty line.

The bottom line

When renovating your home, learning how to finance home improvement projects is almost as important as finding a good contractor to complete the job. Selecting the wrong type of home renovation financing can saddle you with unexpected costs or leave you without enough money to complete the project.

Compare the financing options above to determine which one matches your needs and budget. A longer term loan can reduce your monthly payment, but you'll pay more in interest overall, while a home equity investment has no monthly payments.